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Sunday, October 24, 2004

The Capitalist Philosophy of Alternative Energy

Damn you Ian and Stirling - I'm feeling under the weather and didn't want to expend the energy to write anything - but you have practically forced me to say something with your own writing.

Yes. Unfortunately it's a question of decentralization and marginal costs. The essential problem is that the marginal cost of petrofuels is higher - but the cost is not priced into the market because of government distortion. When people say that oil is cheaper than solar, what they mean is that it's cheaper if you don't take into account the economic cost of:

1. The first Gulf war
2. The second Gulf war
3. The opportunity cost of lost growth from imposing dictators on various states
4. The capital flight induced when the Federal Reserve manages the Fed Funds against the bbl price of oil for leverage.
5. Pollution and global warming effects

If we were to take all these costs and charge them to the account of our use of fossil fuels I don't think that it would be cheaper at all. We can see this by noting historically that whenever the system designed to keep oil prices low fails, it immediately spikes in price. The natural cost structure of oil - expensive technical digging and then shipping a substance halfway around the world in huge quantities and then complexly chemically treating it and then redistributing those petrochemical products - is inherently capital expensive on a commodity which should give it a low rate of return because of its higher marginal costs.

On the other hand, the price of semiconductors has dropped massively because of general increases in technology.

Don't you find it odd that DRAM has become commoditized because of mass production and huge advances in technology - but that solar cells haven't nearly approached this level of change?

Of course they are not the same thing, computation is different from solar energy conversion. However it suggests a difference in capital investment and that there are economies of scale that are not being exploited.

The reason why they are not being exploited? Subsidy and market distortion by government both regulatory and intervention such as the Fed.

We take it for granted that the marginal cost of petrofuel consumption is lower than the marginal cost of alternative fuels. If one takes a serious look at the structural costs of either approach, I think that any sane person would have to question that assumption.

As Holmes said, once you have eliminated the impossible then whatever left however improbable is the answer. It seems difficult to me to argue anything other that the marginal cost of petrofuel consumption, even neglecting environmental costs, is higher.

Yet it is not in practice. Whenever you see a product being sold on a market at lower than its cost structure indicates one must always suspect subsidy and/or marketshare undercutting efforts.

I would argue that it is already, and probably has been for at least five maybe ten years to switch much of our consumption to alternative fuels.

The problem has been that the initial capital needed to fund investments and create economies of scale in production and distribution have not been invested. The reason why they have not been invested is that the market has been price distorted. The reason why the market has been price distorted is that A) a legacy system for maintaining low oil prices when it was necessary has become a political mandate and B) the political system had become habituated to protecting the oil industry.

When we compare alternative energies and the petrofuel economy we are comparing babies and oldtimers. The petrofuel economy is mature, entrenched, has a political constituency, is able to pass its costs off to others in numerous ways, and has had huge amounts of capital invested to capture economies of scale. The alternative energy economy is decentralized and requires a collabortive distribution network instead of the current branching hierarchy system.

You see the petrofuel economy starts with producers and then processors and is then distributed through hierarchial arrangements to local retailers. This system is especially prone to the centralization of profits. By controlling the energy distribution in a top-down manner, it is easy to make a lot of money in a few places with most of the rest of the network being relatively low-profit as they take small cuts of the revenue stream as a charge for passing on the commodity.

However a diverse multi-technology alternative energy fuel economy is going to be much more flat and dispersed. In order to store energy when it is in excess there are going to have to be a lot of fuel-cell batteries sitting around owned by a lot of people to feed back into the distribution net. In order to produce energy there are going to have to be a lot individual homes and businesses that produce wind and solar energy and then feed their excess back into the net in exchange for pulling energy off the net in low-production times. In order to stabilize the system there are going to have to be next-generation nuclear power plants - which won't really be profitable given their high safety and pollution treatment costs - but will have to be subsidized by the rest of the network in order to provide peak consumption megawatts to anchor the entire system. There are going to have to be a lot of regional hydrogen producing and local fuel-cell charging centers to distribute to local retailers or drive-in customers.

What all of this spells is a system which it is very hard to monopolize the profit stream.

And this is one of the reasons why we haven't moved to such a system and why the capital investment is commerically and politically being disincentivized. As Ian pointed out economic activity is not just about wealth it's about domination or what most people refer to as power.

A lot of people who have wealth but more importantly gain their wealth by dominating the present system, have a lot to lose by a switchover to a system where the profits may be greater but they will be more evenly split among many different mouths.

Therefore I would argue that the greatest impediment to a change of our energy-basis and economic restructuring is not as most people assume "marginal cost". The conventional wisdom on the topic is such that when the price of oil rises high enough then alternative fuels become more economically viable. (CSM)

With the price of oil hovering above $55 per barrel, demand is rising for a wide array of alternative energies - from wind turbines to cars fueled by corn oil.

While such devices and fuels always capture attention during spikes in oil prices, the alternative-energy movement is moving well beyond the novelty phase. It is becoming more ingrained in the nation's power grid and in middle-class homes as technologies improve. Consumer demand has Toyota predicting the sale of 100,000 of its Prius hybrid cars in the United States next year.

But this is foolish because you are comparing a mature technology with established capital investments and economies of scale and distribution networks, with a nascent technology without capital investment and lacking economies of scale or distribution networks.

It's like comparing a local minor league player with Babe Ruth - when he was five.

If you look at the extrapolated marginal costs of two mature industries then its clear that the alternative energy economy would have lower and not the higher marginal cost - not at some future unspecified future date of technological advancement but as of the 'state of the art' since perhaps as long ago as the early nineties.

When you look at the real GDP numbers - declining since the mid-nineties and now flat in real adjusted terms - it's clear that once you get past the bullshit accounting that nothing whatsoever is wrong in the real world of non-academic economics. Things are just exactly where you would predict them to be if you kept on subsidizing an antiquated technology with decreasing profitability due to higher costs, kept on basing a national and international currency on it, kept on using the advantage of being the commodity trading currency for petroleum to borrow heavily against the future to maintain an unsustainable level of consumption created by the failure to shift from a energy-balance deficit.

If you ran a business on one technology and started losing money on the trade you could A) borrow in order to maintain a while longer the present losing game B) or invest in a new more profitable technology while you still have the cash or credit to do so in order to get back in the black.

One could argue that if we switched a alternative fuel technology that the demand for oil would drop and the price would drop and others would undercut us using cheap oil. This is false because it neglects two things. The first is that if we were no longer dependent on fossil fuels we could take the money we spend subsidizing and stabilizing the entire world network and invest it in doing something more productive with it. The second item that needs to be mentioned is that the costs of maintaining the network would fall on others and they would be made less competitive by this burden. Without the US to be the "world's policeman" or more accurately "the world's oil security officer" the price of oil would rise precipitously over time.

More concretely imagine all the regimes that would collapse because of the withdrawal of US support and aid. Think of the Kyoto Accords - freed from the shackles of oil addiction the US could stop being the roadblock to worldwide implementation but turn around and press for more stringent standards. It would clearly be in our best interests to do so at that point, because it would make the petrofuel economy less competitive compared to our high tech one. It would be at that point in our best economic interests to see that the carbon emissions would be correctly priced into the market in order to prevent them from undercutting the alternative fuel technologies.

All the economic signals are screaming that it is not just time to make a change, but that we are paying a heavy market penalty for not having started the switch already.

10 Comments:

Good clean argument. A combination of sunk costs, subsidies and intentionally decpeptive bookkeeping have put the world on numbers and the real world looking like they are at odds, when in fact the real numbers reflect the real situation.

First of all, please kindly respond to my "monster" posts in the "dead money" thread. You are putting up articles quicker than I can bring myself to mull over the previous ones & the ensuing discussions.

On the subject matter, let me give an example that I have already cited elsewhere. Some months ago, I believe even last year, a "dollar store" opened in a local strip mall with each item $1 or less. Speculating about the level of patronage & thus merchandise turnover, I was always wondering how such a store can make enough margin to pay just its rent & utility bills, as I suspect the distribution cost of the mostly foreign-manufactured items is a considerable part of the price.

Sure enough, some time back when gas prices increased, they posted signs everywhere to the effect that it's now a "$1.25" store, while explicitly citing fuel & transportation cost increases.

I am citing this as a nice anecdote hinting at things to come when gas prices (or more generally the cost of energy and transportation) remain at this level or, as is more likely, increases. And perhaps money is just one part of the picture, and we cannot get enough energy at _any_ price. Then we will see for what activities we need energy where we have taken it for granted.

That was exactly my reaction to the BOP post, distributed collection of energy is a no no, it would lead to freedom, a little less wage slavery. Another reaction I had to the BOP post was that for the centralized power structure to encourage alternate energy they would have to make a tacit admission that their autistic economic views were wrong. That perhaps growth cannot go on forever, what would happen to the concepts of equities and interest if growth came to a halt?

Damn good analysis. But you are assuming that business people, the rich and gov't will act in a sane manner and allow alternative energy to go forward. The thing is both corporate America and the gov't would fight to the death before allowing people to have more say so in their lives.

The best we can hope for a soviet style solution where the nasty bastards(nomenklatura) who put us in this mess take over the alternative energy field and run it the same way they did big oil - for their benefit.

Technically there still a lot of hurdles to be overcome before much of alternative energy is feasible. The thing is the research should have been started decades ago, not 3 years ago.

As for the technologies.

Solar looks promising. Retrofits for all houses should be mandatory.

Hybrid cars are looking good, but few can afford them.

Hot fusion - a expensive joke and welfare program for math and science majors.

Hydrogen fuel cells - still take more energy to make than they generate. A net loser.

Cold fusion - elusive and very fickle.

Nuclear - looks good and necessary to maintain a high entropic society like ours.

One of the problems with economically pricing out alternative energy is amortizing the initial costs, which tend to be quite high relative to the operational cost. Partly, it is not always clear with new technology how long the material will last. Many of the photovoltaics of the 70’s have failed and are not reparable. Newer technology is more reliable, though the real proof is in the pudding, and therefore not yet known. The more likely problem, though, especially as the technology improves, is the reverse: the initial investment will pay out for far longer than investors are interested in calculating.

For example, there is an SCP (solar heat used to boil liquid and turn turbines; currently this is more efficient than photovoltaics, but requires a bit of scale) plant in the Mojave that has been going gangbusters since 1985. There is every reason to believe it will last decades, concievably centuries, more. How much does that power cost per unit? The initial cost were amortized at thirty years in the calculations, but that is an accounting convention, not the reality on the ground. A longer amortization would mean a much lower calculated cost per unit power. But private market time horizons do not get much longer than that. Religions, artists, and sometimes governments think in centuries; investors do not.

In fact, the increased efficiency with which capital can flitter from flower to flower makes long-term investment generally less attractive. As the costs of moving from one type of investment to another decrease, a long-term investment has not just to beat a given short-term investment multiplied by a greater time, but has to beat any possible sequence of short-term investments that could be made over the same period of time. This will hardly ever be the case.

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